Guest Post: It’s “Heads You Win, Tails You Don’t Lose” With This Currency

One of the most interesting things going on here in Hong Kong at the
moment is the gradual displacement of the US dollar, and even the local
Hong Kong dollar, by the Chinese Yuan.

Walking around town, the signs are obvious: from shops that gladly
accept Chinese Yuan cash for the goods they sell, to the money changers
which now ALL display the Hong Kong dollar / Chinese Yuan cross-rate
much more prominently than the US dollar / Hong Kong dollar cross rate.

In many ways, this is a live economic experiment.

Hong Kong has long had one of the world’s freest, most sophisticated
economies; residents are free to choose what currency to accept (and
save), whether HK dollars, US dollars, Chinese Yuan, gold, or anything
else.

Multi-currency bank accounts are the rule rather than the exception
here, and you can switch freely between all of them with a few mouse
clicks, or phone call. This is one of the reasons why Simon has always
been so keen to recommend banking in Hong Kong.

Yuan-denominated deposits in Hong Kong banks have more than TRIPLED
this year as people look for ways to protect their purchasing power.
Because the Hong Kong Monetary authority pegs its currency to the US
dollar, Hong Kong ends up importing US inflationary monetary.

This is acutely felt. Since Hong Kong is little more than a barren
rock, nearly EVERYTHING is imported… so prices are rising in accordance
with US dollar inflation.

To guard against this constant loss of purchasing power, many Hong
Kong’s residents are converting their savings to Chinese Yuan. While the
Chinese Yuan closely shadows the US dollar, it has steadily appreciated
and is perceived to have significant future upside should the Chinese
ever allow it to appreciate more quickly.

US monetary inflation makes it inevitable that the Hong Kong Monetary
Authority will come up with some sort of a scheme to either peg the
Hong Kong dollar to the Yuan (rather than the US dollar), or perhaps
even replace the Hong Kong dollar with the Yuan altogether.

This would be a HUGELY popular move. Hong Kong is one of the few
places on Earth with a net savings rate; the loan to deposit ratio its
banking system, for example, stood at 81.7% at the end of March, meaning
there are only 81.7 cents on the dollar lent out in Hong Kong for every
$1 on deposit in the banks.

Consequently, savers would love to see the Hong Kong dollar revalued
higher by pegging it to the Chinese Yuan at the current Yuan/dollar rate
of 6.50, rather than the current HK dollar/US dollar peg of 7.80.

What’s more, a move to re-peg the Hong Kong dollar is anything but
far-fetched when you consider that Hong Kong’s net savers club includes
the government, which is sitting on a HUGE surplus. So much, in fact,
that the government recently announced it’s handing back HK$6,000
(US$770) to each Hong Kong permanent resident.

Bottom line, the clock is ticking on a Hong Kong dollar revaluation.
The Yuan is a much better cultural and economic fit, and this brings me
to the crux of today’s letter:

If you have significant expenses to meet in US dollars, you may be
uncomfortable taking on currency risk by parking your money in a more
volatile foreign currency such as the Aussie dollar or Canadian dollar.
Let’s face it, they do have periods where they fall significantly versus
the greenback.

By holding savings in Hong Kong dollars, though, you will have
minimal downside risk if the HKMA keep the status quo and maintains the
US dollar peg. Your Hong Kong dollars will always buy the same amount of
US dollars they buy today.

But, you will have a free “call option” in case the Hong Kong dollar
is revalued higher. It’s a bit like a “heads you win; tails you don’t
lose” situation, and that’s EXACTLY the kind of trade I have dedicated
my professional life to uncovering.